Retail Market's Net Lease is Showing a Shift with More Listings and Higher Cap Rates
The average retail cap rate for net lease properties during the second quarter of 2018 reached 6.2 percent, an increase of 10 basis points from first quarter and the biggest jump in seven years.
Cap rates for net lease retail properties have finally pushed upward.
The average retail cap rate for net lease properties during the second quarter of 2018 reached 6.2 percent, an increase of 10 basis points from first quarter, according to Second Quarter National Net Lease Report from the Boulder Group, a national net lease commercial real estate firm. The last time the rate increased that much was in the second quarter of 2011.
In addition, the Boulder Group reports that the number of retail properties listed has increased, as sellers look to sell assets before cap rates increase further. The number rose by more than 13.6 percent, to 4,216 properties nationally.
Investment sales volume in the single-tenant retail category was just shy of $3.2 billion in the first quarter of 2018, according to the Stan Johnson Co., a brokerage firm specializing in the single-tenant net lease sector. (The firm’s second quarter report is due out later this month.)
Deal flow has slowed. Quarter-over-quarter, single-tenant retail sales volume was down about 14 percent in the first three months of 2018, while year-over-year volume decreased nearly 26 percent, says Lanie Beck, director of research at Stan Johnson Co.
“As second quarter closes, preliminary numbers suggest that single-tenant retail sales volume for the first half of 2018 may fall behind first-half 2017 totals, although the market is still seeing billions of dollars of real estate trade hands,” Beck says. “In the last six months, dollar stores and drugstores continued to dominate the retail landscape as the most often-traded asset types, and that trend isn’t expected to change in the near future.”
The impact of e-commerce on bricks-and-mortar retail has led many investors to focus on retail properties with “e-commerce-resistant and experiential tenants” including medical facilites, fitness centers, restaurants, grocery stores, entertainment venues and convenience stores, says Randy Blankstein, president of The Boulder Group.
“The net lease sectors that demonstrated positive momentum [in the second quarter] included medical, quick-service restaurants, dollar stores and grocery,” he says. That contrasts with the sporting goods and banking sectors, which experienced negative results.
Dollar General, for example, is planning to open another 1,000 new locations over the next year, says John Chang, first vice president of research services with brokerage firm Marcus & Millichap, which reports strong occupancy, tempered development and increasing rental rates for net lease retail properties.
“We also see a lot of restaurants expanding. (As to who’s most successful), it really breaks down to what’s the location, what’s the company, what’s the business model and how are they engaging their customer base.”
Chang says that while the average cap rate is up 10 basis points, “It’s going to vary a lot depending on the terms of the lease, the location of the property, the creditworthiness of the tenant and the size of the asset. There are a lot of variables that go into that.”
From an investment standpoint, there’s still strong demand as private investors are motivated by ease of operations and stable cash flows, he notes. “We see a lot of investors as they come out of more management-intensive properties still looking at single tenant as a fantastic option.”
The new federal tax law that went into effect in December 2017 will play a role for net lease investors, Chang adds. While it will take time to fully grasp how much tax savings the changes could generate, the “new tax law is going to have a very significant impact specifically on single-tenant net lease,” Chang says. “As more companies and more capital comes to market to acquire those assets, it could invigorate activity levels depending on how these pieces fit together.”
Faring better than multi-tenant retail
“If you really drill down to it, net lease has fared much better than shopping centers,” Blankstein says. “Enclosed malls and certainly B and C centers have taken the brunt of the headlines... I believe that the net lease sector is going to be a beneficiary of the changes taking place. You’re going to find stores like Apple, [for example], which are in these enclosed malls. They’re going to go out and build freestanding locations, because they’re the destination tenant and the attraction. I see more freestanding and more single-tenant buildings as people vacate these malls.”
Despite both cap rate increases and new listings, Blankstein says investors remain confident in the sector. While the recent increases can’t be overlooked, overall investment in net lease retail is strong, he notes. He points out that retail net lease cap rates have fluctuated very little, between 6.10 percent and 6.25 percent, for much of the last three years.
“I think the market goes along largely as it is,” Blankstein says of the next six months. “I think people will gravitate toward the A markets, which are essentially the top 25... Assets in the secondary and tertiary markets still trade. They just trade at wider spreads.”
Investors will also carefully monitor Fed monetary policy decisions, along with capital market trends, in order to make necessary adjustments.
“The trend to watch will be what happens with the long-term Treasury rates,” says Chang. “Right now, most are anticipating upward pressure on the 10-year Treasury, and if that happens, it will likely put upward pressure on net lease cap rates… Single-tenant assets are probably the one real estate type that’s most sensitive to what happens with the Treasury rates because they have a fixed yield.”
Article Resource: National Real Estate Investor